Cendant Corporation

Introduction

Cendant Corporation was a supplier of business and consumer services, mainly within the real state
and travel businesses, based in New York. Cendant divided and sold its constituent business, in 2005
and 2006. Despite the fact that the company was located in New York, most of the Cendant’s
headquarters employees were based in Parsippany-Troy Hills, New Jersey.

A product of Hospitality Franchise Systems (HFS) and CUC (Comp-U-Card) International Corporation
merge, Cendant Corporation was formed in December 1997. The accounting irregularities involved
consisted of the inflation of company’s operating income. The scheme was driven by senior
management’s determination that CUC would continuously meet the earnings expectation of Wall
Street Analysts and fuelled by disregard for any commitment that the earnings reported needed to be
“real”.

We can only imagine the high expectations of investors when the boards of directors of CUC
International, Inc. and HFS, Inc. agreed to merge in May 1997 to form Cendant Corporation. The $14
billion stock merger of HFS and CUC, considered an alliance of equals, united two large service
organizations. CUC was a direct marketing giant with shopping, travel, automobile, and entertainment
clubs serving more than 68 million members worldwide, whereas HFS was a franchisor of brand-name
chains such as Ramada, Days Inn, Avis, and Century 21, with more than 100 million customers in the
world. The cross-marketing openings between CUC and HFS were anticipated to form synergies that
would assist the increase of the income and benefit development of the recently formed company,
Cendant.

Henry R. Silverman, chairman and chief executive officer (CEO) of HFS, noted at the time of the merger
agreement that:

This transaction creates a world-class consumer services company with extraordinary revenue and
profit growth potential. By combining HFS's brands and our consumer reach of more than 100 million
customers annually with CUC's direct marketing expertise, powerful club membership delivery
system, and 68 million memberships worldwide, we will create tremendous opportunities that are not
available to either company on its own. In so doing, we have the combined potential for exceptional
earnings and shareholder value creation for two companies that have already established excellent
records in this regard. Walter Forbes and his management team have created one of the most
innovative and successful companies in the history of the services industry. We are confident that by
combining our operating, financial and management strengths, we will create one of the foremost
consumers and business services companies in the world. (Form 8-K, CUC International, Inc., May 27,
1997).

Walter A. Forbes, chairman and CEO of CUC, expressed similar views:

Together, we will benefit from this unique franchise: providing value-added services to consumers and
businesses while substantially enhancing growth opportunities. With similar business models, both
companies have pursued two sides of the same high growth businesses, to compete in a global,
information-intensive and increasingly competitive economy. The combined company will have
increased purchasing power and other advantages associated with greater scale. (Form 8-K, CUC
International, Inc., May 27, 1997)
CENDANT CORPORATION

CUC and HFS merger was finalized in December 1997. Henry Silverman was named CEO, and Walter
Forbes was named chairman of the board. The positions of the two officers were planned to change
on January 1, 2000, with Henry Silverman taking over the role of chairman of the board and Walter
Forbes taking the role of CEO. The merger created a service company headquartered in Parsippany,
New Jersey, with operations in more than 100 countries including over 30,000 employees. The market
value of Cendant's approximately 900 million shares of outstanding common stock at the time of the
merger was estimated to be $29 billion, making it one of the 100 largest U.S. corporations. Cendant,
a global service provider, was positioned to generate superior growth and value opportunities for its
shareholders. As Henry Silverman noted when the merger was finalized.

Cendant arrives at the global marketplace as the world's premier consumer and business services
company, with strong growth prospects. (Form 8-K, CUC International, Inc., December 18, 1997)

At first, Ernst & Young, LLP, CUC's auditor, was held to complete the audit of CUC's 1997 financial
statements, and Deloitte & Touche, LLP, while HFS's auditor, was held to complete the audit of HFS's
1997 financial statements. Deloitte and Touche was slated to be the successor auditor for the newly
formed company. Cendant's 8-K filing with the Securities and Exchange Commission announcing the
selection of Deloitte & Touche as the successor auditor noted that during the past two years there
were no discrepancies between the company and Ernst & Young on accounting principles or practices,
financial statement disclosures, auditing scope, or procedures.

Management organized Cendant's operations around three business segments: travel services, real
estate services, and alliance marketing. The travel services segment facilitated vacation timeshare
exchanged, managed corporate and government vehicle fleets, and franchised car rental and hotel
businesses. Franchise systems operated by Cendant in this business segment included: Days Inn,
Ramada, Howard Johnson, Super 8, Travelodge, Villager Lodge, Knights Inn, Wingate Inn, Avis, and
Resort Condominiums International, LLC.

The real estate services segment assisted in employee relocation, provided home buyers with
mortgages, and franchised real estate brokerage offices. Franchise systems operated by Cendant in
this business segment included Century 21, Coldwell Banker, and ERA. The origination, sale, and
service of residential mortgage loans was handled by the company through Cendant Mortgage
Corporation.

The merge of the marketing segment provided an array of value-driven products and services through
more than 20 membership clubs and client relationships. Cendant's alliance marketing activities were
conducted through subsidiaries such as FISI Madison Financial Corporation, Benefits Consultants, Inc.,
and Entertainment Publications, Inc. Individual membership programs included Shoppers Advantage,
Travelers Advantage, Auto Advantage, Credit Card Guardian, and Privacy Guard.

As a franchisor of hotels, residential real estate, brokerage offices, and car rental operations, Cendant
licensed the shareholders and administrators of independent businesses to use the Company's brand
names. Cendant did not own or managed these businesses. Instead, the company supplied its
franchisee customers with services designed to grow their income and profitability.

FRAUD REVEAL

The high expectations of management and investors were extremely flattened in April 1998, when
Cendant made an announcement of a massive financial reporting fraud misstating CUC's 1997
financial statements, which were generated prior to the merger with HFS. The extortion was
established when responsibility for Cendant's accounting functions was took over from former CUC
personnel to former HFS personnel. Initial estimates provided by senior management of Cendant were
that CUC's 1997 profit should be decreased by approximately $100 million to $115 million.

To play down the aftermath from the extortion, Cendant quickly contracted special legal counsel who
hired Arthur Andersen, LLP to perform an independent investigation. Cendant then fired Cosmo
Corigliano, former chief financial officer (CFO) of CUC, and dismissed Ernst & Young, LLP which was
the auditor for Cendant's CUC business units. The staff of the Securities and Exchange Commission
and the U.S. Attorney for the District of New Jersey also begun investigations relating to the
accounting fraud.

But, the awful news did halt for Cendant. In July 1998, Cendant made an announcement stating that
the fraud was more far reaching than at first accepted, with the accounting records of all major CUC
business units being affected. Cendant re-examined its earlier declaration by informing that CUC's
1997, 1996, and 1995 financial statements would all be repeated. The overall total overstatement of
pre-tax quarterly earnings over the three-year period totalled approximately $300 million.

CUC's management allegedly increased the profit by recording fictive incomes and decreasing cost in
order to meet the expectations of the Wall Street analysts. CUC managers only reviewed the analysts'
earnings estimates and fictitiously expanded incomes and/or decreased costs to meet those
expectations. Meeting analysts' expectations artificially increased CUC's stock prices, subsequently
giving more opportunities to merge or acquire other companies in the future through stock issuances.
The inflated pre-tax quarterly operating earnings grew from $31 million in 1995 to $87 million in 1996
to $176 million in 1997.

The misquotes reflected in CUC's quarterly reports documented with the Securities and Exchange
Commission were not recorded in the general ledger. In any case, for year-end reporting purposes,
CUC made significant year-end adjustments to include the errors into the general ledger. Probably the
most critical, misstatement techniques used by CUC to adjust its general ledger included the following:

• Irregular charges against merger reserves. In its previous acquisitions of other companies, CUC
would record a one-time cost and establish a reserve (risk) for restabilising costs expected to be
incurred as a result of the merger. CUC would later artificially inflate earnings by fictitiously recording
revenues or reducing expenses and reducing the merger reserve (liability) account. The reserve was
used as a cushion to offset poor future performance.

• False coding of services sold to customers. CUC would fictitiously classify amounts received
from customers for deferred income recognition programs as sums paid by customers for immediate
revenue recognition programs. For instance, CUC would improperly record sums gathered for the
Shoppers Advantage program (which expected incomes to be perceived more than 12 to 15 months)
to sums received from the Credit line program (which enabled incomes to be perceived right away).
This misclassification of acquired advantages permitted CUC to promptly perceive incomes and
benefits as opposed to conceding them over the benefit time frame

• Delayed acknowledgement of membership cancellations and bank dismissal of charges made

to members' credit card accounts. Clients were imposed a yearly charge to be a member of the benefit
programs, for example, Auto Advantage. CUC would postpone acknowledging customer cancellations
of benefit programs and bank dismissal of Visa charges to increase incomes and benefits during the
present reporting period.
The last results of the fraud investigation were announced to the public in August 1998. At last, pre-
tax operating earnings were reduced by $245 million, $159 million, and $96 million for 1997, 1996,
and 1995, respectively. Everything considered, more than 33% of CUC's reported profit during the
fraud period were intentionally and falsely fabricated.

MARKET REACTION TO THE FRAUD

Prior to the declaration of the fraud, Cendant's stock was exchanging at a 52-week high of roughly $42
per share. After the second declaration that the fraud was boarder than initially believed, Cendant's
stock dropped to a 52-week low of roughly $16 per share, a 62 percent drop, causing a total market
value to decrease to more than $20 billion. The subsequent drop in Cendant's stock price squelched
the company's planned $3.1 billion cash and stock acquisition of American Bankers Insurance.
Moreover, various lawsuits were filed against the company and the present and former company
officers and directors. On March 17, 1999, Cendant achieved a final agreement on one of the lawsuits
that resulted in a $351 million pre-tax charge to the 1999 financial reports.

ASSIGNING BLAME

Numerous questions remain as a result of the CUC fraud. How could CUC's senior management and
the board of directors not be aware of the fraud? Where was CUC's audit committee? How could Ernst
& Young, LLP not detect the fraud?

Walter Forbes, chairman and CEO of CUC, and Kirk Shelton, Chief Operating Officer (COO) of CUC,
denied any inclusion or knowledge of the alleged fraud. Cendant's audit committee, which managed
the fraud investigation, concluded that:

Walter Forbes and Kirk Shelton because of their positions, had responsibility to create an environment
in which it was clear to all employees at all levels that inaccurate financial reporting would not be
tolerated. The fact that there is evidence that many of the senior accounting and financial personnel
participated in irregular activities and that personnel at many of the business units acquiesced in
practices which they believed were questionable suggests that an appropriate environment to ensure
accurate financial reporting did not exist. (Form 8-K, Cendant Corporation, August 8, 1998)

They also noted that:

Senior management failed to have in place appropriate controls and procedures that might have
enabled them to detect the irregularities in the absence of actual knowledge of those irregularities.
(Form 8-K, Cendant Corporation, August 8, 1998)

Data acquired during the fraud investigation suggests that Cosmo Corigliano, CFO of CUC, coordinated
or knew about several of the irregular activities noted during the investigation. The additional proof
also suggests that Anne Pember, the controller of CUC, who reported directly to Corigliano,
coordinated people to do a proportion of the irregular activities noted. Overall, more than twenty CUC
employees were identified as taking part of the fraud.

How could CUC's board of directors and audit committee not to uncover the fraud? The board of
directors for CUC met a few times during the year and audited financial reports that contained the
fraudulent information. Were the outside directors too cosy with senior management? Four of CUC's
directors were noted as having personal ties with Walter Forbes through other joint investments in
new companies.

Did Ernst & Young, LLP exercise the professional scepticism required of an external auditor? Were the
auditors inappropriately influenced by CUC workers who were formerly hired by Ernst & Young? Two
alleged leaders in the fraud, Cosmo Corigliano and Anne Pember, along with two other financial
managers of CUC, were previously hired by Ernst & Young. Moreover, Cosmo Corgliano was an auditor
on the CUC engagement prior to being hired by CUC. The audit committee report on the fraud
investigation notes several instances in which Ernst & Young did not substantiate or question
fraudulent transactions. In any case, the report additionally demonstrates that the senior
management of CUC urged subordinates to hide certain information to the auditors. Moreover, the
report notes occasions in which the auditors acknowledged evasive answers from management
regarding CUC's financial performance.

During the late 1980s and early 1990s, CUC was required to correct its financial statements, that were
filed with the Securities and Exchange Commission, several times for using aggressive accounting
practices, such as capitalizing marketing costs in place of using the standard practice of expensing
them as incurred.

SUGGESTION

Financial statement fraud or fraudulent earnings management has been an increasing issue in the
business world. The responsibility for detecting financial statement fraud is generally attributed to a
company's external auditors. However, the auditing profession has been very circumspect in defining
its role in fraud detection.

There were a few factors that existed at CUC before the merger that allowed for a favourable
environment for fraud to exist. Above all else, the upcoming merger with HFS generated the pressure
at CUC to provide strong financial statement performance. In combination with this, upper
management put a pressure on the employees at each dimension to get involved in shady exchanges,
with one employee even testifying that he was under the impression he was just “doing his job.” Also,
it was established during investigations that CUC had weak internal controls for a company of its size.
Cendant declared that 60% of reported net income by CUC in 1997 did not exist. Another instance for
this was the absence of an automated accounting system in areas such as recording income. Such a
system would have helped record income in the right time intervals instead of all at once as they were
doing, vastly inflating current revenues.

With respect to the internal controls, auditors have the responsibility to gather an understanding of
the design and implementation of internal control in order to assess the control risk of the company.
This is typically done through inquiry of the client, re-performance of procedures, observation or
inspection. This is a basis for beginning the audit process and forming a strategy for how to proceed.
Of the five interrelated components, the control environment can be seen as the umbrella for which
the other four parts fall under. This is because without an effective control environment, the other
parts will be less likely to provide quality internal controls

External auditors shall take this consideration in auditing on financial statement of any company:

• Recounts of inventory and unannounced visits to locations.

• Interviews of financial and non-financial client personnel in different locations.

• Requests for written confirmations from client employees regarding matters about which they
have made representations to the auditors.

• Tests of accounts not normally performed annually.

• Tests of accounts traditionally or frequently deemed "low risk."

Conclusion

Fraud is said to be the deception that is made by one individual or a group for personal benefit or to
damage another individual or to take his money in an illegal way. The meaning of fraud is
predominantly dependant on legal jurisdiction. Fraud is said to be the crime, and the violation of the
civil law. The most common type of fraud is defrauding individuals of money.

There are about 9 common types of fraud, which include: asset misappropriation, false accounting,
computer fraud, intellectual property fraud and insurance fraud, infringements or thefts by third
parties, corruption, investment scheme fraud, and money laundering.

It is possible to commit fraud by such means as mail, internet and phone.

Risk situation on fraud commitment can be categorized as profits, processes and people. Some
situations taken independently may not indicate on the motivation to commit a fraud but taken along
with other factors will appear to become a motivational factor.

To prevent fraud and enhance ethical behaviour in the company, organizations should develop code
of ethics according to their core values and establish services of internal audit and monitoring.

Companies should also obtain all possible information about their employees, business partners and
suppliers, as well as monitor flow of information between them, to diminish possibilities of fraud.

Fraud at Cendant Corporation was the first significant case of fraud in such tremendous scales.

REFERENCE

EDWIN MCDOWELL, 2nd July 1996, HFS Will Acquire Employee-Controlled Avis for $800 Million in Cash
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controlled-avis-for-800-million-in-cash-andstock.html (Accessed on 04/06/2019)

St. James Press, 2002. "Cendant Corporation" International Directory of Company Histories, Vol. 44.

Adams, Bruce, 2000 "Cendant's Moves Reinforce its Internet Strategies," Hotel & Motel Management,
p. 17

GRETCHEN MORGENSON, 9th May 2004, SUNDAY MONEY; Before Enron, There Was Cendant available
at: https://www.nytimes.com/2004/05/09/business/sunday-money-before-enron-there-was-
cendant.html (Accessed on 4/06/2019)

Chris Morris, 5th August 1998, available at:

https://money.cnn.com/1998/08/27/companies/cendant_folo/ (Accessed on 04/06/2019)